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Say Bye-Bye to the Free Market



July 12, 2008 – Comments (3)

More at Pencils Blog.

U.S. Weighs Takeover of Two Mortgage Giants

Friday July 11, 12:35 pm ET

WASHINGTON — Alarmed by the growing financial stress at the nation’s two largest mortgage finance companies, senior Bush administration officials are considering a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen, people briefed about the plan said on Thursday.

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

Government bailouts are one thing, but this is essentially nationalizing the companies. The enormous side effects of artificially easy money and easy credit are beginning to show. A correction has been long overdue and consistently delayed by the Federal Reserve. Printing money out of thin air at any time is not going to come without consequences. Both physically and psychologically it is extremely damaging long-term. History proves that. Never throughout history has any country gone down the path of fiat money and come out better for it. Currency debasement has been tried since the beginning of government as means of stimulating the economy, and it has always failed. Unfortunately, the U.S. is in a stickier situation given that the dollar is the reserve currency of the world (thanks to the time when the dollar was seen as good as gold). As much as people like to argue that these times are different and a fiat monetary system fits in modern times, it simply isn't true. In the long run, government bailouts and nationalizing companies cannot and will not solve the problem. The only way to solve the problem in a way that will promote long-term stability and security is to let the market forces work. The easy, simple short-term solutions always look like the way to go, but the problem will not go away. So as bad as this situation may or potentially may be, ignoring the signs the market is sending is far more deadly in the long run. Clearly Fannie May and Freddie Mac screwed up and are paying the consequences of easy credit and money. Subprime mortgages are an extremely risky business and the government and the Federal Reserve are telling these businesses that the government will be behind them pretty much no matter what happens.

Politics and economics are more involved than ever today. Over these past few years I believe we have moved in a potentially fatal direction away from a free market and a free society. Government bailouts and takeovers send the absolute wrong message and will probably increase speculation in the markets as well. Bailouts are nothing new, but the rate at which they are increasing and expanding both in amount and size is very alarming. People need to accept that businesses fail. Taking risks without acknowledging the possible outcomes is foolhardy and is not something a government bailout will teach. Of course, a lot of this comes back to the policies from the Federal Reserve. It's frustrating, although not surprising, that increased regulation and increased power to the government and the Federal Reserve are seen as the answers to the problems. All in all, don't expect to see a shortage of money being printed and debt being created in the years ahead.

"A disordered currency is one of the greatest political evils." -- Daniel Webster

"I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs." -- Thomas Jefferson

"Inflation is the one form of taxation that can be imposed without legislation." -- Milton Friedman

"The Federal Reserve banks are one of the most corrupt institutions the world has ever seen. There is not a man within the sound of my voice who does not know that this nation is run by the International bankers." -- Congressman Louis T. McFadden (speaking in the Senate)

"It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." -- Henry Ford

"The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it." -- John Kenneth Galbraith

3 Comments – Post Your Own

#1) On July 12, 2008 at 4:29 PM, DemonDoug (30.95) wrote:

Pencils, great post.  I do have to disagree on one point though.

Say Bye-Bye to the Free Market

The market was never free to begin with.

Everything else spot-on.


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#2) On July 12, 2008 at 4:40 PM, TMFPencils (99.85) wrote:

Hi DD,

Well, over the past century, you are right that the economy without government intervention and/or socialism was unheard of. However, in the 19th century prices often decreased (as they naturally do in a free economy) and the economy was quite free of government intervention. But now the intervention has escalated to a whole new level, a dangerous level.



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#3) On July 12, 2008 at 6:10 PM, blade5adj (< 20) wrote:

Although we are no where near a free market, as you suggested, to have any sort of cohesive system of governship you can't have a totally free market.  To have a stable form of currency, you have to have "the lender of last result", in our case the fed, which serves as the backstop that makes our currency exist and hold value.

Fiat money exists because of the problems that the gold standard money brought about in the Great Depression.  One of those included the inability of the value of money to auto correct, and the lack of control that the fed was able to have over its value and amount in the market.  In the short term, the fed has the ability to print more money (i.e. lower interest rates), and although this increases inflation, it's commonly known that in the short term unemployment and inflation more or less have a direct trade off between each other.  That is, often times a country's central bank will sacrifice inflation for lowered unemployment to help ease a recession or economic downturn.  The problem with the Reagan era and the first term of President Bush was that they were some the first times that the government ran a budget deficit in a time of economic prosperity.  Because of this, when bad times actually do come about, the government has to incur more debt, thus making people even more concerned.  Because there is a fairly large wall between the fed and the government, it is expected that political forces cannot affect interest rates, hence our stable level of inflation.

The fact that inflation is increasing is only bad because then actual inflation will be greater than the expected inflation at the beginning of the year/when debt was issued.  That is, people that owe money to creditors will get a better deal because the real interest rate (nominal interest rate - rate of inflation) will be lower for them than they thought it was going to be.  When there are significant differences between expected inflation and actual inflation, this is what causes people to lose faith in the government backing the currency and hence that market.  This causes lenders to become a lot more stingy, because they never know what the real interest rate will be.

The United States has one of the lowest levels of inflation in the world (also most steady, aside from the ECB), and because of this, one of the most stable currencies.  Although credit has been far too readily available, what we are going through right now is nothing like what happened say in Argentina in 2002, when the government essentially defaulted on their debt and the economy crashed like none other. 

Because the value of the dollar is not tied to any commodity, in and of itself it becomes its own commodity.  The value of the dollar is determined by how much people are willing to pay for it (in terms of other currencies) and how much of a commodity people are willing to sell for a dollar.  If the value of the dollar goes down, our exports increase, which over time should raise the value of the dollar, because people are buying more American goods so the demand for dollars goes up.  The Euro area has been worried about inflation lately too, and this is not a problem that has been unique to the united states.

It's been shown that deflation is far worse than inflation, because then companies stop selling goods because the idea is they could get a better deal if they wait.  Hence a low, steady level of inflation.

As to your fury over the nationalization of FNM and FRE, you should know that it was always given that these companies walked a weird line between being a government entity and being their own company.  People invested in these companies because they new the government would not let them fail.  If you were to see the nationalization of some other company, that was not subsidized or regulated by the government directly, that'd be a different story.  That, however, is not the case.

I'm curious what your alternative would be to banking.  Would you prefer to go back to a bartering system?  I assure you, this would cause far more problems.

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